Question from a reader of The Globe’s Carrick on Money newsletter: I have a great gig working in tech and I’ve decided to move back in with my parents, something many of my friends are doing. I can work remotely and save the money that I would have spent on life and rent in the big city. Ultimately, my plan is to move to a smaller town outside of Waterloo. I currently have $5,000 in savings and my goal is to grow that to $20,000 by the middle of next year.
My questions are: Should I put those funds in a tax-free savings account? I’ll be opening a new account, so who has the best incentives? I will also need to be motivated to save those funds to work towards my savings goal – do you have any suggestions on that front?
Answer from Natasha Knox, a fee-only certified financial planner and founder of Vancouver-area based Alaphia Financial Wellness: Congratulations on landing a great gig in your industry and for taking advantage of this tremendous financial scaffolding opportunity that your parents are giving you.
You are essentially asking two basic questions: how and where to save, and how to keep your motivation up so you can reach your goal. I will start with the motivation question because all my other responses flow from there.
Here’s the thing about motivation: you can increase your motivation to a degree, but it’s best not to rely on motivation alone, as it can be hard to sustain over the long haul. A much more sustainable approach is to rely on purpose, habits and automation.
The first thing that you need is a clear understanding of what this money is for. Is it to build up a solid contingency fund before you move out again? Get a jump start on retirement savings? Make a large purchase of a different kind? Many people find it difficult to save for an unspecified reason so pick something that is meaningful to you.
Once you’ve identified your purpose, try a bit of journaling to connect more deeply to your reasons for doing this. Ask yourself: “If I achieve this, what will be different a year from now? Why is this important? How will I feel when I achieve this?” You may surprise yourself with what emerges for you when you start writing.
You already have the first step to automating nailed down – a targeted savings amount. Now you need to set a firm date by which you’d like to have the additional $15,000 saved. Divide 15,000 by the number of months between now and your goal date, and you will have your monthly savings goal.
The next step – and this is critical – is to automate. Wherever you decide to save, set up the savings to be automatically withdrawn from your account each time you get paid.
Now, on to how and where to save. The answer to this depends on your savings goals. Here are two possible scenarios:
1. You plan on using the savings for a large purchase within the next couple of years.
In this situation, you could save within your TFSA, and use a high-interest savings account for saving inside the TFSA, provided you have the room. You will have started accumulating TFSA room at age 18. Here is a list of various high-interest TFSA savings accounts across the country. The beauty of the TFSA is that once you’ve taken the funds out, all of that room becomes available again the following year, and you will be able to hold different investments inside your TFSA, for longer-term purposes.
2. You plan on using the savings for a contingency (or emergency) fund, with no specific timeline for using it. It just needs to be liquid.
In this situation, my suggestion is the same as the above, but with a small twist. Once you’ve reached your $20,000 goal, you’ll want to transition your money out of the TFSA into a regular savings or a high interest savings account. At the end of the year, transfer an amount equal to how much you plan to save above and beyond the additional TFSA room that you will gain in the following year, and place it in a regular savings account.
For example, if you know you have room in your budget to save $18,000 the following year, move $12,000 out of your TFSA into a regular savings account in December, and then in January you will have new room of $6,000, plus you will regain $12,000 of room which you can use for investments. This approach will maximize your tax sheltering.
The reason for this twist has to do with the nature of contingency funds. Although they may decrease or increase at different points in our lives depending on what situations arise, the need for them is ongoing, rather than short-term.
While it can make sense to initially use your TFSA for this purpose when this is your only savings, you don’t want your precious TFSA room to be tied up for something that has little to no potential for long-term growth.
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